Ten Reasons I am Buying Activision Blizzard (ATVI)

In my previous blog post Taking Profits in Towerstream (TWER), I mentioned that I would reinvest half the proceeds from Towerstream into the gaming industry leader Activision Blizzard (ATVI), making the company not only the largest position in the SINLetter Model Portfolio but also the largest position in my personal (after tax) portfolio.

While I occasionally make some risky trades, for the most part I am a conservative long-term oriented investor with the stock portion of my portfolio spread out between 15 to 25 stocks. Excluding company stock, I tend to keep individual position sizes to no more than 5% of the overall portfolio. Research has demonstrated that the benefits of diversification diminish once you have over 30 stocks in your portfolio. However in the case of Activision Blizzard, I have started building a more concentrated position that I expect to pay off in the next two to three years.

This post is about the key reasons I personally believe Activision Blizzard appears to be an attractive investment and why it now accounts for 13% of the SINLetter model portfolio and 10% of my personal portfolio. My goal is to eventually build this position until it represents 20% of my personal portfolio. Since I have already covered the basics of why I like Activision Blizzard in the September 2008 investment newsletter, here are 10 reasons for making Activision Blizzard a core holding.

Activision released the highly anticipated game Call of Duty: Modern Warfare 2 last week and racked up $310 million in sales from the United States and United Kingdom over a 24 hour period. To put this in perspective the blockbuster Batman movie “Dark Knight” brought in $155 million during its opening weekend. With Christmas right around the corner, the final sales numbers for this edition of Call of Duty are going to be much bigger.

World of Warcraft: Cataclysm for the MMORPG (Massively Multiplayer Online Role Playing Game) World of Warcraft (WOW) is expected to be released in 2010, bringing two new playable races to the 11.5 million active users who pay every month (or by the hour in China) to continue playing World of Warcraft.

The Blizzard division of Activision that created WOW also has another potential blockbuster game called Starcraft 2 scheduled for release in the first half of 2010. More than a decade after the release of the original Starcraft game millions of people are still playing it on Blizzard’s online service called Battle.net. Starcraft 2 will be split into 3 games called “StarCraft II Terrans: Wings of Liberty”, “StarCraft II Zerg: Heart of the Swarm” and “StarCraft II Protoss: Legacy of the Void”. Given that WOW: Wrath of Lich King sold 2.8 million copies in the first 24 hours after its release and went on to become the best selling game in PC history in 2008, sales of these three titles are probably going to be impressive as well.

Activision’s line up of franchises like Guitar Hero and Call of Duty continue to perform well. According to Activision’s CEO Bobby Kotick Guitar Hero was the year’s “#1 best-selling third-party franchise in North America and Europe” through September 2009.

With the increase in mobile gaming both from regular devices like the Nintendo DS and smartphones like the iPhone, Activision gains additional distribution channels for its content. Shortly after the release of Call of Duty: Modern Warfare 2, the company release a pared down version of the game for the iPhone called Call of Duty: World at War: ZOMBIES. I may consider posting a review of the game on my iPhone apps related website AppStruck.com

Shifting gears beyond the product to what makes the stocks interesting, the company reported better than expected results when it reported third quarter results, gained 3.1% market share and ended the quarter with $2.7 billion in cash and investments and no debt.

The company repurchased nearly a billion dollars of its own stock ($960 million to be precise) as of 9/30/09 out of a $1.25 billion share repurchase program.

Activision reiterated its earnings target of 26 cents per share for full year 2009 on a GAAP basis. On a non-GAAP basis, earnings are expected to be 63 cents per share. The discrepancy between the two is primarily on account of deferred revenue related to online games like WOW. Activision has to spread out revenue from such games over the life of the subscription instead of when it actually makes the sale.

Using the non-GAAP revenue number of $4.5 billion and earnings of $0.63, we get a forward P/E of 18.55 and P/S of 3.3. Backing out the $2.7 billion in cash and investments from the $14.83 billion market cap, I arrive at an enterprise value of $12.13 billion and an EV/Sales ratio of 2.7. I have no qualms about paying under three times annual sales for a company that expects to post (non-GAAP) operating margins of over 25% for full year 2009.

A CEO who turned a $440,000 investment into the largest gaming company with a market cap approaching $15 billion over nearly two decades despite never having picked up a joystick.

Sure there are risks to buying Activision just like there are with any investment. My biggest worries are huge recent insider sales especially by Activision’s CEO Bobby Kotick, Blizzard’s notorious reputation for not shipping a game “until it is ready”, a recent drop in video game software sales, longer console refreshment cycles and a general market decline after a powerful rally from the March lows. But those are topics for future blog posts and having exhausted my supply of midnight oil, I am going to call it a night.

Comments

Good question PC. At first glace, I thought it had something to do with deferred revenues related to subscription games like World of Warcraft (WOW) but that is already included under current liabilities.

Looking at the balance sheet on the latest 10-Q filed with the SEC, it appears that there is a deferred income tax line on the assets side just like there is a line under liabilities. The deferred income tax (assets) is $727 million for the latest quarter, while the deferred income tax (liabilities) is $685 million.

I wonder if it has something to do with France’s Vivendi owning a majority stake in Activision.

Thank you Vani. I am however disappointed that my limit order to buy the stock after I published the newsletter did not get filled. Hopefully others managed to get in and benefited from the recent rise.

vaniJanuary 4th, 2010

Asif, congrats on surpassing 100k once again! TWER is flying today. Glad that I sold only 50% when you made the call.

I have taken an extended break from publishing the regular newsletter to focus on my new site Insider Trade Reports (http://www.insidertrade.net) and hence have not updated the model portfolio since last year.

I keep planning on reviving the free newsletter but have not been able to do so due to time constraints.